Question

Econ201

Please solve your personal solution and """do not copy"""

Case Study

When taxes induce people to change their behavior—such as inducing Jane to buy less pizza—the taxes cause deadweight losses and make the allocation of resources less efficient. As we have already seen, much government revenue comes from the individual income tax in many countries. In a case study in Chapter 8, we discussed how this tax discourages people from working as hard as they otherwise might. Another inefficiency caused by this tax is that it discourages people from saving.

Consider a person 25 years’ old who is considering saving $1,000. If he puts this money in a savings account that earns 8 percent and leaves it there, he would have $21,720 when he retires at age 65. Yet if the government taxes one-fourth of his interest income each year, the effective interest rate is only 6 percent. After 40 years of earning 6 percent, the $1,000 grows to only $10,290, less than half of what it would have been without taxation. Thus, because interest income is taxed, saving is much less attractive.

Some economists advocate eliminating the current tax system’s disincentive toward saving by changing the basis of taxation. Rather than taxing the amount of income that people earn, the government could tax the amount that people spend.

Under this proposal, all income that is saved would not be taxed until the saving is later spent. This alternative system, called a consumption tax, would not distort people’s saving decisions.

Various provisions of the current tax code already make the tax system a bit like a consumption tax. Taxpayers can put a limited amount of their saving into special accounts—such as Individual Retirement Accounts and 401(k) plans—that escape taxation until the money is withdrawn at retirement. For people who do most of their saving through these retirement accounts, their tax bill is, in effect, based on their consumption rather than their income.

European countries tend to rely more on consumption taxes than does the United States. Most of them raise a significant amount of government revenue through a value-added tax, or a VAT. A VAT is like the retail sales tax that many U.S. states use, but rather than collecting all of the tax at the retail level when the consumer buys the final good, the government collects the tax in stages as the good is being produced (that is, as value is added by firms along the chain of production). Various U.S. policymakers have proposed that the tax code move further in direction of taxing consumption rather than income. In 2005, economist Alan Greenspan, then Chairman of the Federal Reserve, offered this advice to a presidential commission on tax reform: “As you know, many economists believe that a consumption tax would be best from the perspective of promoting economic growth—particularly if one were designing a tax system from scratch—because a consumption tax is likely to encourage saving and capital formation. However, getting from the current tax system to a consumption tax raises a challenging set of transition issues.”

Q1: What should be taxed - Personal Income or Personal Consumption and why? Provide your opinion based on the case given below. (200 words)    [2.5 Marks]

Q2: How may it affect Saudi Economy if an income tax is imposed in KSA? (200 words)    [2.5 Marks]

Answer 1

Answer 1. According to me personal consumption should be taxed , as what most of the economists suggest . It would be a long term income for the government. Earning people gets demotivated when they see that a part of their income is taken away by the government . Most of them won't understand that it is for their benefit but for people it is like they work very hard to earn that money and government deducts a part of it in just a blink of eye . This type of taxation system makes the earners to find search for illegal ways to save their income or they try different strategies to escape from paying taxes. Taxes on the consumption of consumers will be a good idea as consumers will feel that their personal income is not getting targeted but they have to pay for what they buy and it is normal. It will motivate people to work more and earn more to spend more . It won't demotivate them like past that no matter how much they earn to have to pay some part of it to the govt. Purchasing power is in the hands of consumers . It depends on them how much to purchase , when to purchase and by whom they can purchase . More than half of tax stealing and illegal ways of escaping from tax will come to an end . A person saves money to spend it later on important occasions and there is no way a person will never spend his income , some day at some point of time the person is going to spend his income and when he does government will gain income .

Answer 2.Keeping the current situation in view there are chances they KSA will introduce income tax as the economy is shrinking because of current pandemic. If income tax is imposed in Saudi the govt. is going to face a big oppose from public , from years you are spending your whole money on yourself and suddenly someone comes and orders you to pay some part of your income to them annually or monthly what will you do ? Oppose, yes this is what people will do . Economically , In saudi the purchasing power of people will automatically go down.